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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Residex & Real Estate

Posted by Muthu on February 9, 2013

There have been mails and calls asking as to why I’ve not written a piece as committed – two posts a month.

Firstly I’m grateful to those who asked. This shows you are reading what I write:-)

Though I’m no way a creative person, still even to write these pieces need some kind of thought flow. There are periods when the brain goes blank. So if I write some thing during those phases, I would find the output horrible. The only criterion for posting a piece is I should feel comfortable. I’m aware that you may find many posted pieces itself as horrible:-) All I can do is to request you to bear with me.

I was looking at Residex, a city wise housing price index created and updated by National Housing Bank. It was started in 2007 with base as 100 (like Sensex was started with base as 100 in 1980).

Let us first see Mumbai. As of Sep’12, the index was at 198. So the returns are 14.63% per annum. For Bangalore, 100 has become 98 in 5 years; implying a negative return of -0.4% per annum. For Hyderabad, the index is at 84; a negative return of -3.42% per annum. Ahmedabad has been growing its infrastructure very well. Still the index after 5 years stands at 180, implying a return of 12.47% per annum.

Now let us come to Chennai. The index stands at 312 after 5 years. This means the prices have grown by 25.55% per annum. Prices in places like Kolathur have multiplied by whopping 7 times. Many people expect the same growth in Chennai for next 5 years. That means the index should be 973 in 2017. To explain this, a flat bought for Rs.75 lakhs in 2007 should then be quoting at Rs.7.5 crores!! We can see our fallacy clearly when we put some numbers.

Residex gives details for various areas in each city. Though Bangalore prices have registered a negative growth of -0.4%, Lavella road has grown by 2 times, annualized return of 15.5% per annum.

Coming back to Chennai market, many people here are upbeat that last 5 years return would repeat itself resulting property prices becoming 3 or 4 times in next 5 years. This piece is dedicated to them:-) 

From 1995 to 2003, both in Chennai and many other parts of India; real estate prices remained almost stagnant and the transactions also became less. A bull run in property prices has multiplied the prices around 8 times in the last 9 years, a return of 26% per annum.

As we’ve seen above, places like Bangalore have corrected and has gone down in prices and even Mumbai grew only by 14.63% per annum during the last 5 year period. Chennai prices continue to go only in one direction- that is up and up. If this kind of trend happens to any asset, one can be sure it is becoming an asset bubble. Asset bubble always collapse or correct.

Correction can be two kinds – price and time correction. Price correction is like flat prices correcting by 20% to 25% in some areas of Bangalore in the last 2 years. In real estate, especially in a populated country like India, time correction can happen more than price correction.

What is time correction? You purchase a flat today for Rs.1 crore. After 5 years, the price is still Rs.1 crore. Your capital is intact. Right? No, your capital has eroded due to time correction. Assuming an inflation of 8%, the flat price would have eroded by around 35%. As we’ve discussed in the past, yesterday’s money and today’s money are not same due to inflation which is still least understood when people calculate their gains or losses. Though in nominal term the price is same; in real term the value of investment have eroded significantly.

Will time correction happen in Chennai? Likely. I feel so. In OMR region, there are 50,000+ flats which are completed but remain unsold. I hear from people who deal with real estate that around 40% of new projects remain unsold. I’ve interacted with few who are unable to sell their flats for more than last one year. Used flat market seems to be struggling. We need to remember that many buy flats with the objective of flipping it after few years. They may be in for disappointment. People buying a flat for primary residence needs to use their discretion. 

Much has been said how one can get tax sops, leverage the capital ten times etc. However taxes, repairs and maintenance, interest etc. are not considered. Talking about interest, if someone has been paying EMI for last 5 years, check with your bank as to how much principal has been reduced during the above period. You’ll be shocked to find out as to how little the principal has reduced despite paying 60 installments.

I’m not saying not to buy a house. But like any other asset, the valuations are important. If you buy it at any price with borrowing, it would be long before you even recoup your capital value.

What are the things that need to be looked for?

1)     Usually husband and wife take the loan together and one of their salaries completely goes for EMI. A woman’s career can have breaks due to family situations and many are not prepared for this contingency. This not only leads to financial problems but marital problems as well.

2)     When we bought our house, we borrowed only 40% of the property value. Make it a point to save atleast 50% of the property value as down payment; till then live in a rented place. 10% down payment means you work rest of the life for welfare of the bank.

3)     The house price to rent ratio should be around 15. If a house cost Rs.1 Crore and the annual rent is Rs.3 lakhs; the price to rent ratio works out to 33, which is very expensive. Going by international standards, if this ratio is above 20, then the cost of owning is considered higher than cost of renting.

4)     If the above ratio is 15, then the rental yield will be 6.7% per annum (example: Property price is Rs.30 lakhs and annual rental is Rs.2 lakhs). So the ideal rental yield should not be less than 5%.

5)     Value of the property should not be more than 3 times your take home pay. If you take home Rs.12 lakhs per annum and buy the above flat at Rs.1 crore, you are committing almost 9 years of your current salary. You are stretching a lot financially. You are borrowing a lot from your future income which is uncertain.

6)     Home loan EMI as a part of your income (debt to income ratio) should not exceed 35% to 40% (maximum). Anything beyond this may put a huge strain on you especially in a rising interest rate scenario or any other contingency in life like what we discussed above.

Teaser loan rates at lower EMIs in initial years would do more harm than good. The debt to income ratio would get skewed after the euphoria of owning the house has evaporated.

Applying the above three – Rental yield, loan to annual income and debt to income ratio, the current real estate market in Chennai looks very unreal to me.

Home ownership is becoming beyond a dream of the common man. I’m not even referring to the poor or lower middle class. Even for the middle class or higher middle class, it is not about a dream home but dreaming about a home. Logic and past evidences suggest that this cannot remain like this forever.

Like I say for equity markets, in real estate markets too, we should aim for decent and not exorbitant returns. Aiming for doubling in 3 years or tripling in 5 years is a road to doom. Some may click but many may fail. In stocks, some one can make even 5 times in 2 years but this is more of exception than rule. In the long run, investors as a group cannot earn more than what market gives, be it stock or real estate provides. 

As I’m in the profession of reviewing people’s financial health, I find that once I remove the value of self-occupied property, which is usually under 20 years loan and gold jewellery, the net worth is very meager even for high income people.With this kind of balance sheet you would never be able to retire; not only that unexpected injury or disease can even make you bankrupt. I will write more about this in some other piece. Let us enjoy when the going is good:-)

8 Responses to “Residex & Real Estate”

  1. Milind said

    Thank You Very Much Mutthu.Missed you over entire month . Awaiting next article already

  2. Ramcharan said

    Every middle class home buyer should read this article

  3. Usha said

    The best writing is done with a clear mind and when you have something concrete to say. You’re doing great!

  4. Swami Prasad said

    One of the best Article written by you… Thank you so much for the eye opener ….

  5. Sathyan T said

    Thanks for the eye-opening article – I recognize myself as the category of people you mentioned in the last paragraph 🙂

    BTW, please help me to understand the point no 3 and 4 regarding price to rent ratio, rental yield. I did not get the math…

    Thanks once again.

    • Muthu said

      In Point 3, if you divide Rs.1 crore by Rs.3 lakhs, the resulting number is 33. This number should not be more than 15. If it crosses 20, then renting is a better option than owning.

      For point 3, as I’ve illustrated, if the property price is Rs.30 lakhs and the annual rent is Rs.2 lakhs, the resulting number is 15. If you divide 2L by 30L, the rental yield is 6.7%.

      • sathyan T said

        Does this mean, I am better-off paying 3 lakhs annual rent than buying that house for 1 crore? And in the case of 2L rent for 30L house: at 6.7% yield, am I better-off keeping the 30L in stock-market and pay the rent than buying that house?

  6. amol said

    thanks Mutthu!
    as always…excellent piece of information…please write some more article about investment in real estate

    how far the prices are going to increase so irrationally….it seems next generation can’t at all afford to buy house in Indian cities if prices continue to grow like this…The maths of economy has been twisted by this industry

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